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Draghi softens tone on inflation

Wed, Apr 25, 2012, 01:00

European Central Bank president Mario Draghi has softened his tone on inflation, saying the risks are now "broadly balanced".

While inflation will remain above the ECB's 2 per cent limit this year, it will slow in 2013 and "underlying price pressures should remain modest", Mr Draghi said in Brussels today.

The ECB head stepped up his rhetoric on price risks in March after the ECB lifted its inflation forecast for this year to 2.4 per cent. Since then, the sovereign debt crisis has worsened, threatening to derail the fragile economic recovery in Europe, and oil prices have eased.

"Risks to the outlook for price developments are broadly balanced," Mr Draghi said today. "Upside risks could stem from higher than expected oil prices and further indirect tax increases; downside risks could arise from weaker than expected economic activity."

Budget cuts by governments and surging unemployment are curbing economic growth. Euro-area services and manufacturing output declined for a third month in April, business confidence fell in March and industrial orders dropped for a second month in February.

Mr Draghi, whose call for a fiscal compact to toughen budget rules was adopted by European Union leaders, today urged them to take similar steps to foster growth.

"We've had a fiscal compact," he said. "What is most present in my mind now is to have a growth compact. I think that's what we have to have."

He gave no indication today that the ECB was poised to provide more support for banks or governments but also said the time was not right to consider rolling back its crisis-fighting measures.

There are growing expectations in financial markets that the ECB will have to step in again, with Spain under intense pressure, the Dutch government having collapsed over budget plans and latest data showing the euro zone is being driven back into recession.

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The word from the currency region's central bankers is very different - having created more than a trillion euro of low-cast, three-year money via so-called LTROs to avert a credit crunch, governments and banks have been given space to cut debt and clean up balance sheets.

Mr Draghi rammed home that message in an address to the European Parliament's economic committee.

"Now, the ball is entirely, squarely in the court of governments and banks," he said.

However, he added that any "exit strategy" from the ECB's emergency measures, something Bundesbank chief Jens Weidmann and others have said should be discussed, was premature given weak economic conditions.

Mr Draghi said banks must strengthen their finances further, including by retaining earning and bonus payments, while governments must stick with fiscal austerity drives which in some cases are driving countries deep into recession.

"We are just in the middle of the river that we are crossing," he said. "The only answer is to persevere."

The ECB had played its part in buying governments time.

"Our LTROs have been quite timely and successful. If the only thing we had achieved is to buy time, which by the way is not the only thing we achieved, we would have been successful. I think buying time is not a minor achievement," Mr Draghi said.

The euro zone's business slump deepened at a far faster pace than expected in April, data showed on Monday, suggesting the economy will stay in recession at least until the second half of the year.

Mr Draghi conceded recent data had been mixed though he expected overseas demand and the ECB's still very low interest rates to support growth.

"At the same time, downside risks relate in particular to a renewed intensification of tensions in euro area sovereign debt markets and their potential spillover to the real economy," he said.

Despite the political stand-off in the Netherlands, the immediate pressure is off. Spanish and Italian 10-year government bond yields fell today and are both comfortably below the 6 per cent mark which starts to flash danger signals.

ECB executive board member Jose Manuel Gonzalez-Paramo said Spain would not find it hard to meet its financing needs for the rest of the year despite rising borrowing costs.

Madrid has already met 50 per cent of its planned issuance in medium and long-term bonds for the year, and the ECB policymaker said in an interview published in Expansion newspaper today it would complete its plans well before year-end.

Other euro zone central bankers added to the drumbeat of comments suggesting the ECB is in no mood yet to create more long-term money for banks, let alone resume its government bond-buying programme, which has essentially been inactive for the past 10 weeks.

Mr Draghi said the bond-buying scheme was "neither eternal nor infinite" while Bundesbank board member Andreas Dombret said banks should not rely on the ECB providing unlimited liquidity as an alternative to adjusting their business practices as the policy will be removed before it creates risks to financial stability.

Socialist Francois Hollande, favourite to take the French presidency next month, has called for the ECB's mandate to be revised to add a responsibility for promoting growth.

Mr Draghi insisted the ECB's primary mandate was to ensure price stability and had to remain so.